Method of recording and paying declared dividends in an investment company that invests in fixed income securities and has conventional and etf share classes with different dividend payment frequencies

ABSTRACT

A method is are provided to administer an investment company. The investment company issues one or more classes of shares that are bought from and redeemed with the investment company at a net asset value. The investment company also issues one or more classes of shares that are listed for trading on a securities exchange and that are bought and sold in a secondary market at negotiated market prices. One or more computers maintain information regarding portfolio holdings of the investment company and outstanding shares in the investment company. Dividends are periodically declared at a first time interval for the outstanding shares that are bought from and redeemed with the investment company at a net asset value. The amount of dividends to declare is calculated from the information maintained in the one or more computers. Dividends are periodically declared at a second time interval that is different from the first time interval for the outstanding shares that are exchange-traded. Again, the amount of dividends to declare is calculated from the information maintained in the one or more computers.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application is a continuation of copending U.S. application Ser.No. 11/858,668 filed Sep. 20, 2007, which is incorporated by referenceherein in its entirety.

This application relates to U.S. Application No. 60/973,991 filed Sep.20, 2007, converted to U.S. application Ser. No. 11/955,854 filed Dec.13, 2007, now U.S. Pat. No. 7,461,027 entitled “Basket creation processfor actively managed ETF that does not reveal all of the underlying fundsecurities”.

COPYRIGHT NOTICE AND AUTHORIZATION

Portions of the documentation in this patent document contain materialthat is subject to copyright protection. The copyright owner has noobjection to the facsimile reproduction by anyone of the patent documentor the patent disclosure as it appears in the Patent and TrademarkOffice file or records, but otherwise reserves all copyright rightswhatsoever.

BACKGROUND OF THE INVENTION

U.S. Pat. No. 6,879,964 (Sauter et al.), hereafter, “the '964 patent,”which is incorporated herein by reference, discloses a single investmentcompany that issues one or more classes of shares that are bought fromand redeemed with the single investment company at a net asset value(conventional shares) and also issues one or more classes of shares thatare listed for trading on a securities exchange and that are bought andsold at negotiated market prices (exchange-traded shares). The inventiondescribed in the '964 patent has been commercialized by selected fundcompanies of The Vanguard Group, Inc. which now offers exchange-tradedshares (referred to as “VIPER shares” in the '964 patent) as a separateshare class in a plurality of its previously existing equity funds.

It would be desirable to provide a similar class of exchange-tradedshares for investment companies that invest some or all of their assetsin fixed income securities. However, there are many complexities toextending the invention of the '964 patent to these types of investmentcompanies. The present invention addresses such complexities so thatthese types of investment companies can also provide a class ofexchange-traded shares.

BRIEF DESCRIPTION OF THE DRAWINGS

The foregoing summary as well as the following detailed description ofpreferred embodiments of the invention, will be better understood whenread in conjunction with the appended drawings. For the purpose ofillustrating the invention, the drawings show presently preferredembodiments. However, the invention is not limited to the precisearrangements and instrumentalities shown. In the drawings:

FIG. 1 shows a schematic block diagram of one preferred embodiment ofthe present invention.

FIG. 2 shows a flowchart of an active bond ETF basket creation processin accordance with one preferred embodiment of the present invention.

FIG. 3 shows a flowchart of a dividend distribution process inaccordance with one preferred embodiment of the present invention.

BRIEF SUMMARY OF THE INVENTION

One preferred embodiment of the present invention provides methods andapparatus that administer an investment company. The process operates asfollows:

1. The investment company issues one or more classes of shares that arebought from and redeemed with the investment company at a net assetvalue.2. The investment company also issues one or more classes of shares thatare listed for trading on a securities exchange and that are bought andsold in a secondary market at negotiated market prices.3. One or more computers maintain information regarding portfolioholdings of the investment company and outstanding shares in theinvestment company.4. Dividends are periodically declared at a first time interval for theoutstanding shares that are bought from and redeemed with the investmentcompany at a net asset value. The amount of dividends to declare iscalculated from the information maintained in the one or more computers.5. Dividends are periodically declared at a second time interval that isdifferent from the first time interval for the outstanding shares thatare exchange-traded. Again, the amount of dividends to declare iscalculated from the information maintained in the one or more computers.

Another preferred embodiment of the present invention provides methodsand apparatus that administer an actively managed investment companythat invests assets in fixed income securities. The process operates asfollows:

1. The investment company issues one or more classes of shares that arelisted for trading on a securities exchange and that are bought and soldin a secondary market at negotiated market prices.2. The investment company selects and holds a portfolio of fixed incomesecurities that relate to a benchmark index. The selection is made in anactively managed manner such that the duration range of the securitiesholdings is either longer than the duration of the benchmark index (alsoreferred to herein as being “bullish”), close to the duration of thebenchmark index (also referred to herein as being “neutral”), or shorterthan the duration of the benchmark index (also referred to herein asbeing “bearish”).3. The investment company defines a creation unit basket that has aduration that is equal to a midpoint of the duration range of thesecurities holdings of the investment company.4. The investment company periodically publishes the creation unitbasket to facilitate creation and redemption of the exchange-tradedshares.

DETAILED DESCRIPTION OF THE INVENTION

Certain terminology is used herein for convenience only and is not to betaken as a limitation on the present invention. In the drawings, thesame reference letters are employed for designating the same elementsthroughout the several figures.

Shares that are bought from and redeemed with the investment company ata net asset value are referred to interchangeably as “conventionalshares.” Shares that are listed for trading on a securities exchange andthat are bought and sold in a secondary market at negotiated marketprices are referred to interchangeably as “exchange-traded shares” or“ETF shares.”

I. Overview of System

FIG. 1 shows a schematic block diagram of a system 10 in accordance withone preferred embodiment of the present invention. The system 10 issimilar to the system shown in FIG. 1 of the '964 patent, except thatthe “VIPER shares” referred to in the '964 patent are now referred to as“ETF shares,” and there are additional elements provided to facilitatethe present inventive features.

Referring to FIG. 1 of the present specification, the system 10 includesan investment company 12 (also, referred to interchangeably as “theFund”), investors A, B and C (labeled as 14, 16 and 18, respectively),an authorized participant (also known as a “market maker” or“specialist”) 19, brokers 20 and a clearinghouse 22. The investmentcompany 12 includes a first processor 24 that records one or moreclasses of conventional shares issued by the investment company 12, asecond processor 26 that records one or more classes of ETF sharesissued by the investment company 12, a database 50 that storesinformation about the investment company's portfolio holdings (i.e., thepool of underlying securities), and a database 52 that storesinformation about dividend declarations for the multiple share classes(e.g., payment dates, ex-dividend dates, amounts of dividends paid). Inthe presently described embodiment, the first processor 24 records oneclass of conventional shares issued by the investment company 12, suchas a class of conventional shares that has a relatively small minimuminvestment of $1,000 or $3,000 (“investor shares”). Alternatively, theclass of conventional shares could have a relatively large minimuminvestment, such as $10 million (“institutional shares”). In thepresently described embodiment, the second processor 26 records oneclass of ETF shares issued by the investment company 12. However, thescope of the present invention includes embodiments wherein pluralclasses of ETF shares are issued. The investment company 12 alsoincludes a database 28 for maintaining shareholder account data. Foreach shareholder of the investment company 12, the database 28 maintainsa record of the amount of conventional shares. The database 28 alsomaintains a single account that tracks all of the outstanding ETFshares. The investment company 12 further includes a portfolio tradingand management computer 54, a portfolio manager 56, and a database 58that contains the current basket of securities used for creating andredeeming ETF shares.

Investor A represents one or more investors who have purchasedconventional investor shares in exchange for cash. Investor B representsone or more investors who have purchased conventional institutionalshares.

Investors who wish to purchase ETF shares in quantities smaller than aCreation Unit must purchase the shares on the secondary market through abroker. This process is represented by the investors C (labeled as 18),the brokers 20, the authorized participant 19, and the clearinghouse 22.

An authorized participant 19 is a financial entity that maintains firmbid and offer prices in a given security by standing ready to buy orsell round lots at publicly quoted prices. On an exchange, an authorizedparticipant is the member firm that makes a market in the stock andmaintains the limit order book. In the present invention, the authorizedparticipant 19 purchases ETF shares in Creation Units from theinvestment company 12 which are settled through the clearinghouse 22.The authorized participant 19 has a computer 37 for tracking its accountdata. In the current financial industry, the clearinghouse 22 is theDepository Trust Company (DTC). The DTC is a national clearinghouse forthe settlement of trades in corporate and municipal securities andperforms securities custody-related services for its participating banksand broker-dealers. DTC is owned by members of the financial industryand by their representatives who are its users. The use of otherclearinghouses is within the scope of the present invention.

If an investor C wants to purchase ETF shares, the investor C places anorder with its broker 20. The broker 20 then purchases the ETF sharesfrom the authorized participant 19 for the investor C. In this example,the brokers 20 are labeled as broker 34 (broker 1) and broker 36 (brokern). Each broker 34, 36 has a computer for tracking brokerage accountdata for its shareholders, labeled as elements 38 and 40, respectively.Each broker 34, 36 may have many investors. In this example, investor 42(investor C1 ₁) and investor 44 (investor C1 _(n)) have accounts withbroker 34, and investor 46 (investor Cn₁) and investor 48 (investorCn_(n)) have accounts with broker 36.

The clearinghouse 22 has a record of all outstanding ETF shares issuedby the investment company 12.

FIG. 1 shows only purchase transactions. Sell-type ETF transactions areperformed by a reverse of the ETF purchase transactions.

The investment company could be an open-end fund (e.g., open-end mutualfund), a closed-end fund (e.g., closed-end mutual fund), or a UIT. TheETF shares issued by the investment company are publicly listed andtraded on a national stock exchange, such as the American Stock Exchange(AMEX). The investment company could have an investment objective oftracking a specific target index of securities (i.e., an index fund).Alternatively, the investment company could be actively managed by aninvestment advisor in a manner that does not attempt to tightly track atarget index.

In one preferred embodiment of the present invention, ETF shares may beacquired in one of two different ways:

(1) An investor may purchase ETF shares directly from the investmentcompany 12 in exchange for a basket of securities of generallyequivalent monetary value. Preferably, the direct purchase requires apurchase of a predetermined number of ETF shares, known as a “CreationUnit.” The account data is then updated to include the newly purchasedshares. A “Creation Unit” will preferably cost millions of dollars, andthus, Creation Units will be purchased primarily by institutionalinvestors who have been pre-approved.

(2) An investor may purchase ETF shares on the secondary market througha broker. The account data of the investor, as maintained by theinvestor's broker, is then updated to reflect the new number of sharesheld by the investor.

In one preferred embodiment of the present invention, ETF shares may besold or redeemed in one of two different ways:

(1) An investor may redeem ETF shares directly with the mutual fund inexchange for a basket of securities of generally equivalent monetaryvalue. Preferably, only Creation Units may be redeemed in this manner.

(2) A shareholder may sell ETF shares directly on the secondary marketthrough a broker.

II. Active Bond ETF Basket Creation Process

FIG. 2 is a flowchart of an active bond ETF basket creation process.This process may be used in an investment company that invests most,substantially all, or all of its assets in fixed income securities, suchas bonds. In one exemplary embodiment, the process in FIG. 2 operates asfollows:

1. The portfolio manager (PM) 56 of the investment company 12 determinesthat there will be duration ranges for the Fund.2. The PM determines what the boundaries of the duration ranges will be,vis-á-vis the duration of the Fund's benchmark or target index (e.g.,the Bear range is −0.75 yrs to −0.375 yrs, the Neutral range is −0.375yrs to +0.375 yrs, the Bull range is +0.375 yrs to +0.75 yrs).3. The PM determines, based on experience, research and marketconditions, which duration range the Fund should be in (consideringfuture interest rate expectations).4. The PM buys/sells underlying securities so that the Fund's durationrange matches the PM's determination of which duration range the Fundshould be in.5. The PM calculates the midpoint of the Fund's current duration range.6. The PM selects the securities that will be included in the Basket andthe extent of overlap between Basket securities and the Fund's actualunderlying securities (e.g., target 50-75% for a Treasuryinflation-protected securities (TIPS) fund, 40-50% for a non-TIPSTreasury bond fund).7. The PM establishes the respective weightings of the Basketsecurities, so that the duration of the Basket always matches themidpoint of the Fund's current duration range. —For example, regardlessof whether the PM is currently taking a moderately Bullish, mediumBullish, or strongly Bullish position, the duration of the Basket willalways match the midpoint of the Bullish range. Likewise, regardless ofwhether the PM is currently taking a moderately Bearish, medium Bearish,or strongly Bearish position, the duration of the Basket will alwaysmatch the midpoint of the Bearish range. Likewise, regardless of whetherthe PM is currently taking a Neutral leaning towards Bullish, mediumNeutral, or Neutral leaning towards Bearish position, the duration ofthe Basket will always match the midpoint of the Neutral range.8. The contents and weightings of the Basket securities are madeavailable to third parties (including Authorized Participants (APs) andSpecialists) to facilitate Creation Units.9. When those third parties provide the Basket securities to the Fund,the Fund issues Creation Units/ETF shares. As discussed in FIG. 1, thereverse process happens during the redemption process.

In one preferred embodiment, the Fund's Creation Basket is publishedonce each business day via any suitable electronic or print media.Although the Creation Basket is expected to sufficiently closely trackeach applicable Fund, each Fund's Adviser preferably will not discloseintra-day changes in the Fund's investment portfolio to AuthorizedParticipants or change the Deposit Securities during the day to reflectchanges in the Fund's investment portfolio.

The composition of the Creation Basket must very closely resemble thecomposition of the investment portfolio of each Fund in order that (i)the market value of the Creation Basket will closely track the same-dayNAV of that Fund's ETF shares, and (ii) specialists and market makerswill have sufficient information about that Fund to maintain reasonablespreads between the bid and offer prices of ETF shares. Because eachFund is actively managed, however, the Fund has a fiduciaryresponsibility to keep confidential the exact composition of the Fundsand changes to the composition of the Funds so as to prevent frontrunning and free riding. This duty of confidentiality prevents theproduction of a Creation Basket that exactly mirrors the full portfolioholdings of the Funds. That is, the Creation Basket should not revealall of the Fund holdings. The Creation Basket described hereinaccomplishes this goal.

The desired level of tracking between the market value of the CreationBasket and the same-day NAV of the Funds is achieved by selecting theweightings of the securities in the Creation Basket according to tworequirements. The first Creation Basket requirement specifies that theCreation Basket must be a representative sample of the securitiescomprising the investment portfolio of each Fund. This requirementensures substantial identity between the Deposit Securities and thesecurities comprising the investment portfolio of the Funds, which willincrease the degree of positive correlation of price movements betweenthe Creation Basket and the Funds' ETF shares.

The second Creation Basket requirement specifies that the Duration andYield Curve Slope Exposure of each Fund's Creation Basket must closelyapproximate the Duration and Yield Curve Slope Exposure of theinvestment portfolio of the corresponding Fund. In the case of Duration,each Fund's Adviser assigns a rating of Bullish, Neutral or Bearish tothe interest rate sensitivity of the Fund's investment portfolio. Foreach of these options, a specific number is defined to be the midpointof a range represented by that rating. Then, the weightings of thesecurities in the Creation Basket are selected such that the Duration ofthe Creation Basket is calculated to be approximately the same as themidpoint of the Duration range which is assigned to the Fund'sinvestment portfolio. This process is also summarized in FIG. 2,described above.

Each Fund's Adviser also structures the securities which comprise theCreation Basket so that the Yield Curve Slope Exposure of the CreationBasket closely approximates the Yield Curve Slope Exposure of thecorresponding Fund's investment portfolio. These controls ensure thatthe Creation Basket and the investment portfolio of the applicable Fundwill have similar exposures to the principal market forces that drivethe performance of a portfolio of U.S. Government and Agency Securities,which will further increase the degree of positive correlation of pricemovements between each Fund's Creation Basket and ETF shares. In afurther alternative embodiment, the Creation Basket further has abreakeven inflation (BEI) exposure that is approximately matched to theBEI exposure of the securities holdings.

The use of these two Creation Basket requirements will usually allow theFund to keep the composition of the Creation Basket unchanged even whenthe composition of a Fund's investment portfolio changes modestly. Forexample, if a Fund were to add a new security, the correspondingCreation Basket would not have to make any change unless the change tothe Fund was of such a magnitude that either (i) the Creation Basketwould no longer be a representative sample of the Fund, or (ii) theoverall duration of the Fund changed to a new range.

The creation basket process may be implemented in an investment companythat offers ETF shares as the only class of shares, or offers ETF sharesas a class of shares in addition to one or more classes of conventionalshares. If the creation basket process is implemented in an investmentcompany that offers ETF shares as the only class of shares, the systemof FIG. 1 would not include the processor 24 that issues theconventional shares, the shareholder account data in the database 28(since there would be no individual shareholder accounts to track), orthe investors 14 and 16 who purchase and redeem conventional shares.

Additional details of the active ETF basket creation process aredescribed in Appendices A and B.

III. Dividend Distribution Process

In most conventional fixed income funds, dividends are declared dailyand paid monthly. As described in Appendix B, there are many reasons whyit would not be practical for funds to declare dividends daily for anexchange-traded class of shares and why the dividend payment datescannot be the same for conventional shares and exchange-traded shares.In one embodiment of the present invention, dividends are declared dailyand paid monthly for conventional shares, but dividends are declaredonly monthly for the ETF share class(es) and paid several days laterthan the payment date for the conventional shares.

FIG. 3 shows a flowchart of a dividend distribution process inaccordance with one preferred embodiment of the present invention. Inthis example, there are two classes of shares, one conventional shareclass, such as the investor shares shown in FIG. 1, and one ETF shareclass. The income earned on the portfolio is allocated daily among theshare classes based on their relative net assets.

Although conventional shares and ETF shares both will pay dividendsmonthly, the payment date for the ETF shares will be a few days laterthan for the conventional shares. The delay in payment of dividends toETF shareholders arises from several related facts. First, dividendscannot be paid or reinvested until the clearing firm knows who isentitled to receive the dividend. Second, for exchange-tradedsecurities, the record date (when the clearing firm first knows who isentitled to receive the dividend) follows the ex date by two days.Third, clearing firms typically need at least two days following therecord date to process the dividend, which could consist of paying cashor reinvesting the dividend in additional ETF shares. Taken together,these facts mean that the dividend will not be available to ETFshareholders until at least four days after ex date, regardless ofwhether it is paid in cash or reinvested.

In contrast to the four day delay between ex date and payment date thatwill be experienced by ETF shareholders, conventional shareholders willhave their dividends reinvested on ex date. As a result, conventionalshareholders will be continuously invested, while ETF shareholders whowish to reinvest will be “out of the market” for four days with respectto amounts distributed by the Funds.

Appendices A and B are Applications for Exemptive Relief filed by TheVanguard Group, Inc. to permit stand-alone index funds that invest infixed income securities (e.g., bonds) to issue exchange-traded sharesand to actively manage the ETF share class. Appendix A is directedtoward an actively-managed TIPS fund and Appendix B is directed towardsa more general Treasury index fund. In alternative embodiments, thefixed income securities may be funds that invest in corporate bonds,mortgage backed securities, international bonds, and the like.

Although the disclosed embodiments are investment companies that investsubstantially all of their assets in fixed income securities, the scopeof the invention includes “balanced fund” investment companies, whereinthe fixed income portion of the balanced fund uses the inventive methodsdescribed above.

In the embodiment of the present invention described above, dividendsare declared daily for conventional shares and monthly for the ETF shareclass(es). However, other differing dividend declaration schedules arewithin the scope of the present invention.

In the embodiment of the present described above, the investment companyhas an investment objective of tracking a specific benchmark index offixed income securities. However, in an alternative embodiment, theinvestment objective is set by an investment advisor, such as in anactively managed investment company, as opposed to tracking a specificbenchmark index.

The present invention may be implemented with any combination ofhardware and software. If implemented as a computer-implementedapparatus, the present invention is implemented using means forperforming all of the steps and functions described above.

The present invention can be included in an article of manufacture(e.g., one or more computer program products) having, for instance,computer useable media. The media has encoded therein, for instance,computer readable program code means for providing and facilitating themechanisms of the present invention. The article of manufacture can beincluded as part of a computer system or sold separately.

It will be appreciated by those skilled in the art that changes could bemade to the embodiments described above without departing from the broadinventive concept thereof. It is understood, therefore, that thisinvention is not limited to the particular embodiments disclosed, but itis intended to cover modifications within the spirit and scope of thepresent invention.

1. In an investment company that invests at least a portion of itsassets in fixed income securities and declares dividends from incomeearned on the assets and that has issued (i) one or more classes ofshares that are bought from and redeemed with the investment company atthe net asset value, and (ii) one or more classes of shares that arelisted for trading on a securities exchange and that are bought and soldin the secondary market at negotiated market prices, and that includesone or more computers and one or more databases that maintaininformation regarding portfolio holdings of the investment company andinformation regarding outstanding shares issued by the investmentcompany, wherein the outstanding shares are shares in the portfolioholdings of the investment company, the outstanding shares including theone or more classes of shares that are bought from and redeemed with theinvestment company at the net asset value and the one or more classes ofshares that are listed for trading on a securities exchange and that arebought and sold in a secondary market at negotiated market prices, acomputer-implemented method comprising: (a) the one or more computersperiodically recording declared dividends for the outstanding sharesissued by the investment company in the one or more databases, the oneor more computers recording declared dividends in the one or moredatabases at a regularly scheduled first time interval for theoutstanding shares issued by the investment company that are bought fromand redeemed with the investment company at the net asset value andrecording declared dividends in the one or more databases at a regularlyscheduled second time interval that is different from the first timeinterval for the outstanding shares issued by the investment companythat are listed for trading on a securities exchange and that are boughtand sold in the secondary market at negotiated market prices; (b) theone or more computers calculating the amount of dividends to declarefrom the information maintained in the one or more databases; and (c)the one or more computers of the investment company paying the declareddividends of the outstanding shares issued by the investment companythat are listed for trading on a securities exchange and that are boughtand sold in the secondary market at negotiated market prices, and theoutstanding shares issued by the investment company that are bought fromand redeemed with the investment company at the net asset value.
 2. Themethod of claim 1 wherein the investment company invests substantiallyall of its assets in fixed income securities.
 3. The method of claim 1wherein the first time interval is daily.
 4. The method of claim 1wherein the second time interval is monthly.
 5. The method of claim 1wherein the first time interval is daily and the second time interval ismonthly.
 6. The method of claim 1 wherein an owner of any share of anyshare class has an undivided interest in the investment company.
 7. Themethod of claim 1 wherein the investment company is an open-end fund. 8.The method of claim 1 wherein the shares that are bought and sold in thesecondary market at negotiated market prices are exchange-traded shares.9. The method of claim 1 wherein the investment company has aninvestment objective of tracking performance of a specific benchmarkindex of fixed income securities.
 10. The method of claim 1 wherein thedeclared dividends of (i) the outstanding shares issued by theinvestment company that are listed for trading on a securities exchangeand that are bought and sold in the secondary market at negotiatedmarket prices, and (ii) the outstanding shares issued by the investmentcompany that are bought from and redeemed with the investment company atthe net asset value have a payment date, each have a respective paymentdate, and step (c) further comprises: the one or more computers payingthe declared dividends of the outstanding shares issued by theinvestment company that are listed for trading on a securities exchangeand that are bought and sold in the secondary market at negotiatedmarket prices at least a predetermined number of days after the paymentdate of the outstanding shares issued by the investment company that arebought from and redeemed with the investment company at the net assetvalue.